What the financial sector needs to know about climate-related risks in the next five years: Navigating the new NGFS short-term scenarios for Europe

The immediate effects of climate-related risks are particularly relevant for the financial sector. Climate stress tests, which are often carried out over three to five-year periods, have become crucial for assessing the impact of shifting weather patterns and evolving climate policies on both the economy and the financial system. This column highlights the key findings for Europe from the first release of short-term climate scenarios by the Network for Greening the Financial System. These scenarios support the analysis of how climate policies and extreme weather events might affect the financial system and the economy through 2030.

As climate change intensifies and policy responses evolve, there is a growing consensus in the literature that climate risk is already significant for banks in the short term (Noth and Schüwer 2023, Batten et al. 2016, Vermeulen et al. 2021, ISDA 2023). Beyond the direct impact of damages from climate hazards or the sudden repricing of financial assets, climate-related risks lead to changes in behaviour and thereby in macroeconomic outcomes in the near term (Erlandsen et al. 2025, Bilal and Rossi-Hansberg 2023). So far, the financial sector lacks adequate tools for short-term climate risk analysis. To address this gap, the Network for Greening the Financial System (NGFS) released its first set of short-term climate scenarios in May 2025. This new tool offers insights into the consequences of climate-related risks over the next five years. This is the first release of this tool, which will likely be further improved in future releases.

The transmission of climate-related risks to the economy and financial system

The NGFS short-term scenarios use three interconnected models to capture the complex linkages between climate, the real economy, and the financial system, focusing on the interactions among climate, economic, financial, and technological dynamics (Figure 1).

Figure 1 NGFS short-term scenarios modelling framework

This suite of models provides insights into potential system-wide losses from climate risks, which are often overlooked in current climate scenarios (Reinders et al. 2023). It also incorporates investor sentiment and uncertainty, crucial for modelling the pricing of climate risk in financial assets (Hale and Sharma, 2023). The scenarios provide a wide range of climate, macroeconomic, and financial variables essential for financial risk analysis, delivering granular insights at both sector and country level. They quantify transition risks – arising from policy changes, technological advancements, and market shifts – at the sector level, highlighting vulnerabilities between high- and low-emission sectors. Additionally, they identify ‘winners’ from the green transition, such as sectors producing carbon-neutral technologies and renewable energy, globally. Physical risks, driven by acute and compounding climate hazards, are assessed with detail at regional and sector level. A unique feature of these scenarios is their ability to analyse the effects of a sequence of extreme weather events, a key innovation in climate risk assessment tools. This includes the impact of dry (heat stress, droughts, wildfires) and wet (floods, storms) extreme weather events and their transmission through trade linkages.

The NGFS short-term scenarios explore four distinct narratives about the future of climate change and the economy, designed to assess how various factors – such as climate policies, extreme weather events, and industrial shifts – might shape the world over the next five years. The scenario narratives are as follows:

• Two scenarios tackle transition risks by examining the effects of policy-driven decarbonisation on the economy and financial system. The "Highway to Paris" scenario envisions an early, globally coordinated green transition with well-planned, ambitious climate policies. In contrast, the "Sudden Wake-Up Call" scenario explores the fallout from a rapid shift to more ambitious climate policies, leading to a costlier and more disorderly transition.
• The other two scenarios evaluate the impact of acute physical risks on the economy and financial system, taking into account international trade linkages. The "Disasters and Policy Stagnation" scenario examines the effects of region-specific extreme weather events. Meanwhile, the "Diverging Realities" scenario investigates how extreme weather events in certain regions can affect advanced economies, primarily through shortages of minerals critical for the green transition.

Selected results from the NGFS short-term scenarios

The four scenarios offer unique insights into how climate-related risks might impact jurisdictions globally by 2030. They are grounded in a baseline where all climate policies pledged by January 2023 are implemented, and the macroeconomic context aligns with projections from the 2023 IMF World Economic Outlook. 1

The scenarios reveal that the EU is in a unique position compared to most other regions, as it stands to benefit from a globally coordinated green transition, as described in the "Highway to Paris" scenario. This advantage is due to the EU's early adoption of ambitious climate policies, such as the Green New Deal, which expands the existing EU Emissions Trading System and targets a 55% reduction in greenhouse gas emissions by 2030 compared to 1990 levels. By the end of the decade, the EU is expected to see a modest increase in output (0.1% of EU GDP), higher employment, and only a slight rise in inflation (Figure 2). This scenario assumes that carbon tax revenues are fully reinvested into the economy through subsidies for renewable energy investments, thereby boosting economic activity. However, this boost is insufficient for regions without the EU's ambitious starting point, leading to a global contraction in output under this scenario. The global output losses reflect the economic challenges of aligning climate policy ambitions with the Paris Agreement's goals. Higher carbon prices are anticipated to shift consumer preferences and increase financing costs and risk premia for high-emission sectors. The coal sector is particularly affected, facing lower investor confidence, which raises its financing costs by up to 1.5 percentage points by 2030 (Figure 3, panel a). 

Figure 2 GDP impact, world versus EU
(relative difference to baseline in %, solid lines = EU, dashed lines = World)

The EU outlook changes slightly under the "Sudden Wake-Up Call" scenario, which envisions an abrupt and poorly planned global green transition. In this scenario, carbon tax revenues are only partially reinvested into green subsidies, making the transition more costly. Like most other countries, the EU faces a negative supply shock due to the sharp increase in carbon prices, leading to a slight decrease in output and a rise in inflation. The sudden implementation of climate policies increases investor uncertainty, resulting in higher financing costs, especially in high-emission sectors. Globally, financing costs for the coal sector rise by over 8 percentage points, while in Europe the increase is lower at 1.6 percentage points (Figure 3, panel a).

While the short-term impact of transition risks on the European economy is relatively limited, the NGFS scenarios indicate that Europe is especially vulnerable to extreme weather events. In the "Disasters and Policy Stagnation" scenario, where a series of severe climate hazards hit European countries, GDP losses reach up to 4.8%, with only a gradual recovery in output (Figure 2). Inflation rises due to decreased productivity and increased production costs following natural disasters. Additionally, the risk of default becomes more pronounced for capital-intensive sectors. The EU agricultural sector, particularly susceptible to the combined impacts of droughts, wildfires, and heatwaves, faces an increase in financing costs of up to 6 percentage points (Figure 3, panel b). Overall, the impacts of a sequence of plausible but extreme weather disasters vary across world regions, with Africa facing the highest losses which pick at 13% of its GDP.

Lastly, even if Europe is not directly affected by adverse climate events, its macroeconomic outlook could significantly worsen if physical risks materialized elsewhere. The "Divergent Realities" scenario demonstrates how climate disasters in other regions create macroeconomic spillovers that disrupt economic activity in the EU. In this scenario, shortages in the supply of critical minerals lead to a decline in European output by up to 1.9% (Figure 2). Reduced investment and higher import costs further dampen demand. Notably, as Europe continues its green transition, adverse macroeconomic conditions make this transition more costly compared to the "Highway to Paris" scenario. Similar disruptions affect other advanced economies; for example, North America's GDP is projected to contract by 0.8% by the end of the decade.

Figure 3 Impact of transition and physical risk on financial risk by sector in the EU

Notes: Highway to Paris series are not visible due to overlap with Divergent Realities.

Conclusion

The NGFS short-term scenarios mark a significant advancement in climate scenario analysis, addressing the need to understand the immediate economic and financial impacts of climate-related risks. This modelling framework offers a comprehensive and consistent evaluation of plausible, high-impact climate risks over the next five years. It incorporates sector-specific developments of a net-zero transition, compounding physical risk shocks, and feedback loops between the real economy and the financial system.

These scenarios are essential tools for policymakers and financial institutions to improve their climate risk assessments. As climate change evolves, robust and dynamic scenario analysis will remain crucial for guiding economic and financial decision-making. Looking ahead, future improvements could expand the NGFS framework by including interactions with non-climate-related macroeconomic shocks and a broader range of physical hazards and transmission channels.

Authors’ note: This column reflects the views of the authors and not necessarily those of the European Central Bank or the Network for Greening the Financial System. We thank Irene Heemskerk and Verena Reith for their useful comments. The NGFS is constantly working to further improve the scenarios. Neither the NGFS, nor its member institutions, nor any person acting on their behalf is responsible or liable for reliance on, or the use that might be made of these scenarios.

References

Batten, S, R Sowerbutts and M Tanaka, M. (2016), “Let's talk about the weather: The impact of climate change on central banks”, Bank of England Staff Working Paper No. 603.

Bilal, A and E Rossi-Hansberg (2023), “The importance of anticipating climate change”, VoxEU.org, 24 July.

Hale, G and B Sharma (2024), “Climate beliefs and asset prices”, VoxEU.org, 6 October.

International Swaps and Derivatives Association (2023), “A Conceptual Framework for Climate Scenario Analysis in the Trading Book”, 12 July.

Noth, F and U Schüwer (2023), “Natural disasters and bank stability: Evidence from the U.S. financial system”, Journal of Environmental Economics and Management 119.

Reinders, H J, D Schoenmaker, and M Van Dijk (2023), “Climate risk stress tests underestimate potential financial sector losses”, VoxEU.org, 28 June.

Erlandsen, S K, S-J Ho, D Kyriakopoulou, D A Mahalingam and J Talbot (2025), "Why central banks need to understand the impact of the green transition on the macroeconomy”, VoxEU.org, 14 February.

Vermeulen, R, E Schets, M Lohuis, B Kölbl, D Jansen and W Heeringa (2021), “The heat is on: A framework for measuring financial stress under climate change”, De Nederlandsche Bank.